This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the bottom of any article.

March 4, 2013

Poland Offers Lessons for Europe on Long-Term Growth

As market participants regain their taste for Europe and begin sifting through the many investment possibilities they have before them, Central and Eastern Europe (CEE)—a region that had enjoyed vast amounts of investment in the years prior to the Eurozone crisis, but then suffered subsequent cash withdrawals from its many close links to core Europe—is once again on the radar, as evidenced by the success of recent sovereign bond issues from countries including Poland, Hungary and Romania.

These and other nations have successfully placed close to $6.25 billion in bonds in recent weeks, according to Alexander Moseley, senior portfolio manager of emerging market strategies at Schroders, and that too, at a relatively fair price. “There’s evidently good appetite for lending to these countries, and they have been able to take advantage of favorable market conditions,” Moseley said.

Today, the CEE countries look very attractive from a spread perspective compared with even six months ago, said Vlad Milev, portfolio strategist at the investment firm Payden & Regel. “Now that the overall European risk has reduced, investors are looking at the bonds from Hungary, Romania, Serbia and other countries because they offer better spreads than sovereign bonds from Asia and Latin America, so the recent bond issues were oversubscribed as much because of the countries’ individual positions as their luck of being in the right place at the right time,” he said.

Yet Milev said he was not overly optimistic about the longer-term prospects of the CEE region, which suffered significant setbacks as a result of the Eurozone crisis. While growth in 2013 will be slightly better than it was in 2012, and will certainly top that of core Europe, these countries have in the past ridden the wave of European Union accession, and that made them attractive to foreign investment of all kinds, according to Milev.

That trend is now gone, however, and though these nations can certainly fund themselves quite easily in the capital markets, they must have also have a new investment thesis to back them up for the longer term, one that focuses on generating domestic growth and on building solid local institutions to support and strengthen their domestic economies, Milev said.

Every country is, of course, at a different stage in this process and has a different level of willingness to reform. Romania and Serbia, for instance, are seeking new International Monetary Fund (IMF) programs to enhance the credibility of their reform agenda, while the absence of IMF negotiations in Hungary and Ukraine suggests less appetite for actively pursuing reforms, according to Moseley. “But time and time again, we have seen that countries with weak policies and large stocks of external debt are much less likely to improve in credit quality over time, and this makes them vulnerable to shocks, so reform is key,” he said.

Like many other investors, Moseley points to Poland as an example for other countries in the region to follow. It has one of the largest and strongest domestic economies and a deep local capital market supported by a solid domestic investor base, he said. “Even though Poland is experiencing a cyclical slowdown, the Polish economy is very sound and Poland’s growth surpassed that of the EU countries in the past years, and measures have been taken to stimulate growth,” he said.

While 2013 will no doubt be a challenging year for the Polish economy, Poland is nevertheless bolstered by a number of factors, including stable public finances and a manageable public debt burden that’s strictly mandated by the country’s constitution and is particularly important in the context of the European fiscal crisis, said Marta Petka-Zagajewska, who covers Poland for Raiffeisen Bank in Warsaw.

Furthermore, Poland enjoys a smooth relationship with both the European Union and the IMF, which reassures investors that, unlike Hungary, for example, it is a reliable, predictable and market-friendly partner.

Finally, the Polish authorities have also implemented a number of changes to make the state more “entrepreneur-friendly,” said Petka-Zagajewska, and this helped push Poland up an impressive 19 places in the World Bank’s most recent “Doing Business” report, which compares business regulation in 185 countries across the globe.

Poland’s well-developed and highly liquid local market can serve as an example for other countries, Milev said. Like all other emerging markets, the CEE countries are also wrestling with the implications—negative as well as positive—of opening their local capital markets to foreign investors. But “they have also realized they have more to gain than to lose by this,” he said.